By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
As the holidays draw near, we have seen very little consistency in the performance of the U.S. dollar. The greenback lost value Wednesday versus the euro, Japanese yen and Swiss franc but strengthened against sterling and the commodity currencies. Even with these back-and-forth movements, we are still seeing more profit taking than new positioning in the dollar. Of course this isn’t a surprise as overstretched moves ahead of a major holiday invites liquidation. Better-than-expected U.S. existing home sales and the London close drew some buying interest but as the North American session progressed, profit taking resumed. We could see one final jolt of volatility with Thursday’s revisions to third-quarter GDP, initial jobless claims, durable goods, personal income and spending reports scheduled for release. After that, markets will be in full holiday mode until Tuesday when we could see some additional action before year end.
Short-term price action aside, with the Federal Reserve looking to raise interest rates three times next year, 2017 should be a good year for the U.S. dollar unless the strong dollar kills corporate earnings, Trump tantrums overshadow Trump stimulus and the Fed raises interest rates two instead of three times next year. Time and again, we’ve heard U.S. companies attribute earning misses to currency translations. A strong currency hurts corporate earnings by reducing the value of foreign profits and making U.S. exports less competitive on the global market. According to Factset data, 30% of U.S.-based S&P 500 firms draw over 50% of their revenue from outside the U.S. and the value of this revenue is now less in U.S. dollar terms. We were having this same conversation this time last year when USD/JPY was trading above 120. The strong dollar was also a big problem then and in less than 6 months, it sank down to 100. Considering that there are no less than 10 reasons why the dollar is a headache -- list below -- we hope you understand why it would be dangerous to expect an uninhibited rally in the dollar next year, especially since it’s a crowded view. At the same time, if there are any delays to Donald Trump’s fiscal stimulus program, or there are signs that it may not be as aggressive as he promised, the rally in stocks and the dollar could be unwound. Any of this could lead to less tightening from the Federal Reserve next year. Of course if none of this becomes an issue, it should be smooth sailing to 120 for USD/JPY -- a level that we still expect to reach some time in the coming year.
Consequences of a Strong Dollar:
- Less Exports, More Imports, Wider Trade Deficit
- Lower cpi
- Lower Commodity Prices
- Weaker Earnings for US Companies with Significant Foreign Revenue
- Less Pressure on Major Central Banks like ECB to Ease
- More Pressure on Emerging-Market Nations with Dollar-Denominated Debt
- More M&A Transactions (which may not be a consequence)
- Weaker International Investment Returns
- More Pressure to Outsource
- Less Demand for Currency Alternatives such as Gold and Bitcoin (BTC-eUSD)
Meanwhile, there’s no stronger trend right now than the one in the commodity currencies. The New Zealand dollar extended its losses for the sixth day in a row. Even stronger-than-expected GDP growth in the 3rd quarter failed to lend support to the currency. The economy expanded by 1.1%, up from 0.7% the previous quarter. Economists had anticipated slower growth with the downward revision in Q2, the overall data was better. New Zealand data actually hasn’t been that terrible, even though the trade deficit missed expectations it still narrowed and earlier this week we saw improvements in building permits, business confidence, consumer confidence and service-sector activity. It seems that much of the selling is technical. The break below 70 cents took NZD/USD underneath the 50- and 100-week SMA, opening the door for a move down to the May low of 0.6675. Since we expect a final push higher in the U.S. dollar, a move to this next support level is not only possible but probable for NZD/USD. The Australian dollar also traded lower Wednesday with gold prices remaining under pressure. Westpac’s leading indicator report was also released and a slight slowdown in activity was seen in November.
USD/CAD is in play Thursday with retail sales and consumer prices on tap. A surprise increase in crude oil inventories drove oil prices lower. This helped keep USD/CAD above 1.34 despite a decline in the U.S.--Canadian yield spread. For the past few days, the yield spread has pointed to a sharp move lower in USD/CAD and while we have yet to see the pullback, the data scheduled for release over the next 2 days could be the catalyst for this move.
The euro rebounded against the U.S. dollar on Thursday. The currency pair spent most of the day above 1.04 thanks to better-than-expected European data and U.S. dollar weakness. Eurozone consumer confidence dropped less than expected in December. Furthermore, an official close to Greek negotiations was optimistic that Greece would be reaching a solution with creditors soon. Although this message has been heard before, the optimism offered a boost to the currency. With no economic reports scheduled for release Thursday, euro will trade on the market’s appetite for dollars.
Sterling, on the other hand, traded lower against the U.S. dollar Thursday despite better-than-expected data. Public finances for November came in higher than expected with an increase of £13.5b vs. £-2.3b the prior period. Public sector net borrowing also beat forecasts with an increase to £12.2b when only £11.6b was expected. Sterling’s weakness can be attributed to ongoing concerns about Brexit. Next year is going to be all about how the U.K. economy weathers Brexit. Prime Minister May promised to invoke Article 50 in March so we are only a few months away from what could be another period of major uncertainty and volatility for the currency. The weakness of GBP drove EUR/GBP to its strongest level in nearly 3 weeks.